Insurance investments post-lockdown: Ensuring stable returns in an unstable world
The impact of the COVID-19 pandemic on investment portfolios of insurers and pension funds is not yet fully visible, but already has the potential to cause nightmares to board members across the globe.
Devaluations of traditional asset classes due to increasing spreads on corporate bonds, the cementation of extremely low interest rates, extreme volatility of equity and currencies, and cashflow reductions due to default or moratoria melt down the reserves of insurers, in particular of life insurers and pension funds.
Due to the impact of the pandemic on investment portfolios, AM Best has published a negative outlook for life insurers in the US and in all major European countries. This unprecedented situation leads to a number of operational challenges for insurers and pension funds:
- Market volatility causes breaches of investment quotas defined by insurers and/or regulators (e.g. for real estate).
- Lack of risk capital and/or risk appetite drives insurers into less volatile asset classes, such as government bonds, that fail to provide the return required under the insurance policies.
- Previously stable cashflows from long-term investments such as real estate and private lending are – at least temporarily – no longer available to cover liabilities and to finance payments to policyholders, and insurers must find other sources of liquidity to honour their obligations.
- Reduced liquidity of remaining investments also affects the insurers’ asset-liability management.
- The pandemic calls for changes in the investment risk management procedures (e.g. monitoring of market developments and investment portfolio, reporting to decision-makers, and adaptation of risk reporting to the regulators).
- Mark-to-market valuation of assets under international accounting standards (in particular IFRS9) becomes increasingly difficult and may no longer reflect the real value of the assets.
Available risk capital is consumed by market volatility and the overall solvency ratio decreases because of devaluations of the asset portfolio.
The substantial impact of these challenges has even led to a first major lawsuit against a manager of pension fund assets: the Arkansas Teacher Retirement System has sued Allianz Global Investors over a USD774 million loss in Allianz’s investment funds.
In light of these challenges, regulators and policymakers have remained surprisingly calm and quiet. EIOPA has called on national regulators and insurers to use the flexibility provided by the Solvency II framework to mitigate risks and to preserve solvency capital in the best interests of the policyholders. In addition, EIOPA has acknowledged the extreme market volatility during the COVID-19 lockdown by providing weekly RFR and EDA calculations, and has published a number of punctual alleviations regarding reporting and public consultations. The European national regulators have also proven a steady hand:
- The French ACPR has stressed that the French insurance industry is solid and has sufficient safety margins, but also acknowledged that French insurers will be affected by the decline in their financial income and the sharp decrease in the value of their assets and equity as a result of the financial market downturn.
- The German BaFin has taken a similar stance with regard to German insurers, underlining their solid financial position and the need to act in the best interest of the policyholders. BaFin does not want insurers to rush into emergency sales, and will tolerate temporary investment quota breaches.
- The UK PRA has said insurers should consider not just the potential impact of the virus, but also take full account of the unprecedented level of support provided by governments and central banks to protect the economy, and that the need for well-balanced decisions means due weight must be given to established long-term economic trends.
- The Dutch DNB focuses on business continuity management and risk management in the face of unrest in the financial markets.
- Other European regulators, such as the Italian IVASS, have not made any formal statement dealing with investment portfolio challenges.
While European insurers and their regulators have been surprised by the global COVID-19 pandemic, pandemic emergency planning, in particular for an influenza, has been part of the risk management of Australian insurers since 2013 following respective guidance by the Australia Prudential Regulatory Authority.
In COVID-19-struck Brazil, SUSEP needs to deal with the hit taken by the largest local reinsurer’s risk capital from foreign currency transactions that have suffered extremely from the financial market volatility. It is expected that SUSEP, after completing an ongoing consultation to the market, will publish further restrictions for insurers’ investments.
Many regulators across the globe agree that insurers shall decrease or cancel dividend payments to preserve liquidity and solvency capital. So far most big insurers have nevertheless made the usual profit distributions for 2019 – though some with deferred payments and/or additional safeguards. In the Netherlands, a number of Dutch insurers have headed the Dutch regulator DNB’s call on postponing dividend payments and share buybacks.
So insurers are stuck between Scylla and Charybdis: they can join the flight to safety that is now promulgated by a number of national regulators, but they will in the long run starve from lack of returns. They can go all in into more risky asset classes and thus profit from low market prices and sustainable income but they will potentially risk their solvency status.
In this situation, it is difficult to predict the direction of travel. Our best guess would be that in the short term insurers will focus on maintaining liquidity and reducing volatility. At the same time they will not abandon their ongoing long-term quest for higher returns. This will lead to even more attention on alternative asset classes such as real estate, infrastructure, renewable energies or private lending, with a reinforced focus on digital infrastructure and logistics which have strongly profited from the pandemic. It is also likely the crisis will prompt further consolidation in the insurance sector.
While the asset management industry currently focuses on whether the economic recovery will be a V, U or L shape, three other letters will continue to play an important role. ESG investments have survived their first acid test by outperforming traditional investments and many voices around the globe claim that carbon reduction, human rights and climate change resilience should be placed at the centre of government relief programs.
There is no clear picture yet: while Spain and Australia debate ambitious plans to reach zero emissions, other countries are pledging support to industries and companies that are major consumers of fossil fuel.
One thing is clear: many big insurers, including Allianz, Swiss Re and Zurich, are at the forefront of the global and national “build back better” campaigns. This is no surprise, given that ESG risks are at the top of all lists in the World Economic Forum’s 2020 Global Risk Report.